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RBNZ More Circumspect On The Outlook

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Fuseworks Media
Fuseworks Media
RBNZ More Circumspect On The Outlook

KEY POINTS

The RBNZ left the OCR unchanged at 3.00 percent as widely expected.

The overall tone of the policy assessment and the Monetary Policy Statement was more circumspect, with their growth forecasts downgraded and a substantial downward revision in their 90-day profile (135bps lower by March 2013).

A much weaker outlook for domestic demand is largely behind the growth downgrades. The projections were finalised prior to the Canterbury earthquake impact.

The RBNZ still notes that further removal of policy support will be required, but it will be staggered and they have been explicit in stating that "several on-hold decisions are implied by this forecast."

We see the RBNZ remaining on hold for the rest of this year, with the first hike in March 2010 but the OCR to end 2011 at 4.5%.

We believe the RBNZ was too bullish on growth 3 months ago (and commentators talking a 6% plus OCR endgame) but are now coming in too bearish on 2011 prospects, and hence low on their assessment of where rates will end up. COMMENT AND ASSESSMENT

The no change decision today was widely expected. The real surprise was how much more circumspect the RBNZ was relative to June. The RBNZ did acknowledge that the growth outlook had "softened somewhat" at their July Review, but the extent of the downward revisions did surprise us. Calendar 2010 growth has been revised down from 3.1% to 2.6%, and for 2011 down from 3.8% to 2.5%. This forecast did not incorporate the impact of the Canterbury earthquake. The RBNZ estimates that the earthquake will shave 0.3% off Q3 GDP growth, but add a little in Q4 and add around % to 1%to the level of GDP by March 2012. The RBNZ will look through any temporary inflation impact (largely from higher construction and rental costs in Canterbury) from the reconstruction of Canterbury. The RBNZ does not expect the higher headline CPI inflation from the GST increase to have a lasting impact, and sees underlying inflation remaining at the mid-point of the target band over the forecast horizon.

A much weaker domestic demand outlook has been behind the lower growth forecasts. While the RBNZ sees risks around the global outlook, they are still expecting continued strong growth in Australia and China to support demand for NZ exports. It is the RBNZ's view on domestic demand that has shifted materially from June. Recent dataflow showing an easing in sentiment and still weak consumer spending and housing market has prompted the RBNZ to reassess things, leading to the growth downgrades. This in turn, has resulted in a much lower 90-day profile compared to June.

The statement has seen a massive revision to the 90-day trajectory. The 90-day track is 135bps lower by March 2013 compared to the June Statement. There looks to be two reasons for this. Firstly, the growth outlook is more sedate. The economy is expected to average growth of 2% to 2% over the coming 3 years, which is hardly a resource sapping pace even if you factor in a lower potential growth rate. The second is what looks to be an assumption that bank funding costs will remain elevated throughout the forecast horizon, thereby mitigating the extent to which the OCR has to go up. We concur with the second point but believe the RBNZ has become a little conservative in its economic outlook for the coming years (a sizeable turnaround from June).

Looking forward, we expect a resumption to the tightening cycle from March next year, but the tightening cycle will be protracted and won't be in a straight line, which has been our long held view. Indeed, the RBNZ explicitly stated that "Given that the OCR is only moved in discrete multiples of 25 basis points, several on-hold decisions are implied by this forecast." We see the OCR ending 2011 at around 4 percent. This is more hawkish than market pricing but largely reflects our view that while the economic outlook and recovery is certainly sedate and patchy, we expect momentum to build nicely over 2011. One key reason for our optimism regarding 2011 has always been our less sanguine view towards 2010. And we view a more sedate 2010 courtesy of deleveraging as partially underpinning a more robust 2011. Certainly, we find it difficult to envisage momentum remaining in the 2 percent range next year given stimulus from the Rugby World Cup and Canterbury reconstruction related activity. A degree of permanence in regard to bank funding costs will of course mitigate the degree to which the OCR needs to move up and any tightening profile in 2011 will likely be of a hike, hike, pause variety (read: staggered). But just as we viewed the endgame for the OCR of 6 percent plus as wildly optimistic three months ago, we view something around 4.5 as a little low now.

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